What the SEC’s New Proposed Vendor Due Diligence Rule Means for Financial Advisers

November 10, 2022by Smarsh

Subscribe to the Smarsh Blog Digest

Subscribe to receive a monthly digest of articles exploring regulatory updates, news, trends and best practices in electronic communications capture and archiving.

Smarsh handles information you submit to Smarsh in accordance with its Privacy Policy. By clicking "submit", you consent to Smarsh processing your information and storing it in accordance with the Privacy Policy and agree to receive communications from Smarsh and its third-party partners regarding products and services that may be of interest to you. You may withdraw your consent at any time by emailing privacy@smarsh.com.

In line with an ongoing trend to establish cybersecurity protocols for financial advisers, the SEC recently voted on a new proposal to address vendor due diligence and security. 

As the financial services industry adapts to changing market conditions (demographics, increased assets under management, etc.) and an increasingly digital business landscape, the need to incorporate new tools and services to meet demand efficiently has also grown.

The proposed rule expands the definition of a vendor, which has historically focused on software and cloud solutions. This proposal indicates added emphasis from the regulator on service providers such as consultants, law firms, accounting firms, and others.

Under the Investment Advisers Act of 1940, the new proposal would prohibit registered investment advisers (RIAs) “from outsourcing certain services or functions without first meeting minimum [due diligence] requirements.”

"When an investment adviser outsources work to third parties, it may lower the adviser’s costs, but it does not change an adviser’s core obligations to its clients. Thus, today’s proposal specifies requirements for investment advisers designed to ensure that advisers’ outsourcing is consistent with their obligations to clients."

-- Gary Gensler, SEC Chair

Key elements of the proposal

SEC Chairman Gary Gensler said the organization had “observed an increase in advisers outsourcing and issues related to the outsourcing and advisers’ oversight.”

The proposed rule would include requirements for advisers to:

  • Conduct due diligence before engaging a service provider
  • Periodically monitor performance and reassess whether due diligence requirements are being met, to determine whether the relationship should continue

The proposal would also amend the investment adviser registration form to include more specific information about service providers and their functions. This would offer more transparency for clients and enable the SEC to assess risk and oversee service providers.

The proposed rules reinforce existing obligations covered by an investment adviser’s duty of care, but significantly expand the due diligence obligations under existing third-party due diligence policies.

Proposed vendor requirements

The proposed rule imposes further due diligence and monitoring provisions on third-party vendors that provide recordkeeping functions.

Investment advisers would be required to conduct due diligence to ensure that the vendor can:

  • Maintain internal procedures for producing and retaining records on the RIA’s behalf, to comply with the recordkeeping rule
  • Produce and retain records to comply with the RIA’s recordkeeping rule requirements
  • Allow RIA to access digital records
  • Allow RIA to access digital records even after the vendor’s contract with the adviser terminates or if the vendor goes out of business

Advisers should plan to address these requirements with potential vendors and reassess current relationships to allow for the necessary policy adjustments and agreements.

vendor risk pitfalls

How financial firms can prepare

So, what does this mean for RIAs and firms? Working with vendors is a critical part of doing business — but they must be trusted to access, handle and transmit highly sensitive information.

A vendor risk management solution simplifies the vendor risk assessment process by automating the most resource-intensive parts of third-party risk evaluation and management, including:

  • Flexibility to create any relevant assessment questionnaire
  • Automating the time-consuming process of grading vendor assessments and adjusting contract clauses to match
  • Maintain auditable tracking of remediation plans and validation documentation
  • Real-time reporting for cross-functional visibility
  • Customization of assessments and rules to meet each firm’s unique needs
  • Ongoing monitoring and remediation

As the vendor ecosystem expands and security threats evolve, firms should be proactive in their due diligence process. Performing annual reassessments, armed with a modern vendor risk management solution will help investment advisers stay secure and compliant.

Share this post!

Smarsh
Smarsh Blog

Our internal subject matter experts and our network of external industry experts are featured with insights into the technology and industry trends that affect your electronic communications compliance initiatives. Sign up to benefit from their deep understanding, tips and best practices regarding how your company can manage compliance risk while unlocking the business value of your communications data.

Ready to enable compliant productivity?

Join the 6,500+ customers using Smarsh to drive their business forward.

Get a Quote

Tell us about yourself, and we’ll be in touch right away.

Smarsh handles information you submit to Smarsh in accordance with its Privacy Policy. By clicking "submit", you consent to Smarsh processing your information and storing it in accordance with the Privacy Policy and agree to receive communications from Smarsh and its third-party partners regarding products and services that may be of interest to you. You may withdraw your consent at any time by emailing privacy@smarsh.com.

Contact Us

Tell us about yourself, and we’ll be in touch right away.